Where does the risk go?

One of the ways that takeovers hide risk is to have the company borrow money; another is to put the risk onto the workers — both to demand them to take lower wages or to extract value from pensions and the like. Both are often used in the same deal.

In an earlier post, I noted the borrowing associated with the Zell takeover of Tribune.

“Financial engineering is central to the deal announced earlier this month to sell Tribune to Sam Zell, a real-estate tycoon. Although the purchase price was advertised as $8.2 billion, Mr Zell will have to cough up only $315m.”

“One of the main attractions of this arrangement is that the ESOP structure will bestow huge tax breaks on Tribune. The benefits to employees are less clear. Mr Zell has not said anything about giving workers a bigger say in running things. And Tribune will stop making matching contributions to employees’ individual retirement schemes; instead, pension provision for employees will now consist entirely of shares held by the ESOP.”

“Some form of ESOP is reportedly also part of each of the various bids for Chrysler, the struggling American arm of DaimlerChrysler. When Daimler bought Chrysler in 1998, it paid $35 billion. Analysts now value it at no more than $8 billion, though Daimler may be fortunate to get anything close to that for a business that some experts think is destined, sooner or later, for bankruptcy, along with Detroit’s other giant car manufacturers, Ford and General Motors.”

“On April 5th Tracinda, the investment vehicle of Kirk Kerkorian, a buy-out veteran, offered to pay a paltry $4.5 billion for Chrysler. Mr Kerkorian’s offer assumes that Daimler will retain some of Chrysler’s crippling health-care and pension liabilities and that the firm’s employees will take a big chunk of equity in exchange for giving up some promised benefits.”

“Some 10m American workers are members of ESOPs, which together control assets worth an estimated $600 billion.”

“One success was Floturn, a troubled machine-tool maker that was bought through an ESOP from its parent, Belcan, in 1988. The management got the employees to help overhaul the firm’s business, which led to huge improvements in productivity and profits. That rare triumph must be contrasted with the more typical experience of United Airlines. In 1994 an ESOP bought 55% of its equity, not least because the unions saw that as the only way to stop the then chief executive from making big (and, with hindsight, essential) job cuts. After an initial success, the unions and management quickly reverted to confrontation. In 2002 United entered bankruptcy, and the ESOP became worthless. Tribune and Chrysler would do well to avoid a similar fate.”